Grim Illinois forecast sets table for cuts and MLF borrowing

Bonds

Illinois’ $7.8 billion unpaid bill backlog will soar to $35 billion in 2026 without structural fixes to the state budget, Gov. J.B. Pritzker’s administration warned in a new five-year forecast that sets the stage for spending cuts and deficit borrowing.

After voter rejection Nov. 3 of a progressive income tax structure that would have generated $3 billion in new annual revenue, the state will need to identify other revenue sources and it’s eyeing the closure of corporate loopholes but Pritzker stressed Monday that cuts will come first.

“We are starting here with cuts,” Pritzker said when asked about the forecast. “We will start to talk about other things when we get there but right now it is very important that there is some agreement across the board and right now there isn’t necessarily agreement across the board” with legislative leaders, he said, adding that the administration is working on it.

Deficits of between $4.2 billion to $4.8 billion are projected annually over the next five years unless the fiscal 2021 gap is closed with structural fixes. That red ink would be piled on to the existing backlog, causing it to surge. Any borrowing through the MLF that must be repaid within three years could further fuel growth in the backlog.

In the absence of recurring fixes, the backlog grows to $10.2 billion in at the close of fiscal 2021 on June 30, $15 billion in fiscal 2022, $19.6 billion in fiscal 2023, $24.5 billion in fiscal 2024, $29 billion in fiscal 2025, and $33.2 billion in fiscal 2026. Rating agencies track the accounts payable number as a sign of the state’s fiscal stress and liquidity position.

Bleak long-term projections overshadowed some brighter data in the report published Friday.

The state raised current-year revenue projections by $2.2 billion, including $1.94 billion from improving income and sales tax collections. That leaves a $3.9 billion hole to fill this year.

The adopted fiscal 2021 budget initially projected a more than $6 billion hole due to $4.6 billion in projected tax losses tied to the COVID-19 pandemic’s economic impact. The state also must repay $1.2 billion in notes that helped erase a $2.7 billion 2020 pandemic tax hit and $400 million in borrowing through the treasurer’s office.

The revised deficit does not count up to $5 billion in borrowing the state may do through the Federal Reserve’s Municipal Liquidity Facility. It was authorized by lawmakers in the $43 billion fiscal 2021 general fund budget as a bridge to potential future federal relief that has so far failed to materialize.

It also doesn’t count existing general obligation borrowing authority cited in budget documents as a replacement for $1.27 billion of anticipated new revenue from the progressive income tax amendment that voters rejected earlier this month.

“Governor Pritzker continues to work with Illinois’ congressional delegation to advocate for federal fiscal stabilization dollars for state and local governments,” Alexis Sturm, director of the Governor’s Office of Management and Budget, wrote in the economic and fiscal policy report, which is published every November.

“Regardless of whether additional stimulus dollars materialize, the governor will explore the following options to address the current year shortfall as well as deficits in future years,” Sturm wrote, including carrying out governor-directed spending reserves at agencies under his authority, additional spending reductions or revenue enhancements as approved by the legislature and seeking “a prudent level” of MLF borrowing.

Any amounts borrowed must be repaid within three years, putting additional pressure on out-year budgets, the report warned.

Pritzker has already asked his agency directors to identify potential 5% cuts for the remainder of fiscal 2021 and to submit fiscal 2022 budget request with a 10% reduction. Those requests have not been factored into the projections laid out in the report.

Pritzker has warned cuts alone would be too onerous especially given that 75% of the budget is obligatory spending on items like pensions and debt service.

“A structural deficit of the size that Illinois is facing cannot be addressed by spending cuts alone. Dramatic cuts in state services would stifle long-term economic growth for Illinois” and harm critical education services, the report warns.

The analysis reports that the governor will work with the legislature to identify corporate and business tax loopholes that can be closed and tax adjustments that can be made that minimize the impact to lower- and middle-class families.

GOP lawmakers, who are in the minority, want Pritzker to cut immediately using his own authority. Democrats have pitched closing what they call corporate tax loopholes and some civic groups have suggested the state consider taxing retirement income and expanding the sales tax to cover services before raising the 4.95% income tax rate.

The revised figures adhere to the “pessimistic IHS economic forecast and a blend of pessimistic and baseline forecasts for the rest of the forecast period,” the report noted.

Revenues are expected to hit $39 billion this year, up 2.5% or $952 million from fiscal year 2020 base levels with the three largest revenue sources — individual income tax, corporate income tax and state sales tax — accounting for $30.1 billion. That’s up 4.4% or $1.3 billion from 2020. The increase is largely due to $1.2 billion of income taxes due in 2020 that flowed into state coffers during fiscal 2021 after the state extended the filing deadline to July from April.

Expenses four months into the new fiscal year are tracking close to prior expectations but at $39 billion are $1.8 billion, or 4.7%, up from fiscal 2020. Expense growth from fiscal 2020 is mostly driven by pension payment growth.

Future fiscal years will strain the state’s already battered fiscal foundation due to rising expenses from pension contributions, human services, public safety and a planned annual $350 million increase in education funding. A shift of motor fuel sales tax revenue from the general fund to the road fund also continues. Pension contributions from the general fund are projected to rise to $10.6 billion in fiscal 2026 from $8.6 billion this year.

Revenues, based on existing sources in place, rise to nearly $44 billion in fiscal 2026 from $39 billion this year but don’t keep pace with rising expenses unless changes are adopted.

The deficits beyond fiscal 2021 are due to the state’s structural budget woes outside of tax losses associated with the pandemic. Pritzker had hoped to tackle the structural gaps with the $3.1 billion of new revenue expected if voters had approved moving to a progressive income tax rate structure from the current flat one, raising taxes on top earners.

“Changes to address this structural deficit will need to be undertaken,” the report warns. “A balanced fiscal year 2021 budget would allow the state’s outstanding accounts payable to be maintained at the $6.2 billion level seen at the end of fiscal year 2020. This level was $1 billion lower than the state’s backlog at the end of June 2019, and nearly $1.8 billion below the amount of accounts payable when Governor Pritzker took office.”

The backlog stood Tuesday at $7.8 billion with nearly 86,000 bills owed, according to Comptroller Susana Mendoza’s website. The backlog hit a peak of $16.7 billion in November 2017 after a two-year budget impasse that ended in July that year. About $6 billion in borrowing brought it down to $9 billion by the end of the year. It hit a low of $5.4 billion for the start of fiscal 2021 on July 1.

The state must tread cautiously to preserve its investment grade ratings, which are all one downgrade away from junk at the BBB-minus level. No state in modern history has fallen to speculative grade territory. Fitch Ratings, Moody’s Investors Service, and S&P Global Ratings all assign negative outlooks.

Action on a budget fix is not expected until early January when a lame-duck legislative session is expected. Leaders canceled a brief veto session slated for this week and in early December amid the surging number of COVID-19 cases at the capital and across the state.

The state faces an early December deadline to file a notice of intent to borrow through the MLF program, which is scheduled to expire at the end of 2020. The state’s bonds continued to trade this week at high-yield spreads to the Municipal Market Data’s AAA benchmark of 180/304/292 basis points on the one year, 10 year, and 20 year, respectively. That’s a 10 basis point narrowing from the 30 bp widening they saw the day after the amendment failed.

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